Vedder Thinking | ArticlesLessors of Major Aircraft Parts Take Heed, Your Parts May Be At Risk

Wells Fargo Bank Northwest, N.A. v. RPK Capital XVI, L.L.C. et al.1 (the RPK Case) is a recent case that presents a cautionary tale to leasing companies in the market of leasing major aircraft parts to operators. Because aircraft are moveable assets that are regularly traded in the secondary market, lessors of major aircraft parts always have faced the risk that an unscrupulous lessee could transfer possession of, and possibly title to, the leased parts to a buyer of the aircraft on which the leased parts are installed. The Uniform Commercial Code (the UCC) generally provides that a lessee of goods may not transfer an interest beyond the leasehold interest it holds in those goods. However, an exception to this general rule exists, whereby a buyer in the ordinary course of business2 (a Buyer in the Ordinary Course) may acquire title to those goods.3 This so-called “Buyer in Ordinary Course Exception” also applies to leased goods that have become accessions to other goods, in that a Buyer in the Ordinary Course may acquire title to leased goods that have become accessions when it acquires title to the whole goods to which the accessions were installed or affixed.4

Facts of the Case

The RPK Case involved a lease of an aircraft engine, thrust reverser and other related equipment by RPK Capital XVI, L.L.C. (RPK) to ATA Airlines, Inc. (ATA). ATA installed the leased thrust reverser onto an aircraft it leased from FINOVA Capital Corporation (FINOVA). During the term of the lease, ATA filed for bankruptcy. As part of the bankruptcy proceedings, ATA assumed the RPK equipment lease and rejected the FINOVA aircraft lease, returning the aircraft to FINOVA with the leased thrust reverser still installed. FINOVA then sold the aircraft to Talos Aviation Limited (Talos), which conveyed title to Wells Fargo Bank Northwest, N.A. (WFB) as owner trustee in order to hold the aircraft in trust. RPK and RPK Capital Management, L.L.C. (collectively, the RPK Parties) sued WFB for conversion of the thrust reverser. The trial court awarded the RPK Parties possession of the thrust reverser, and WFB appealed the decision.

Court’s Analysis of the Buyer in Ordinary Course Exception

In applying the Buyer in Ordinary Course Exception, the appellate court posited that a lessor’s interest in a good it leases can be subordinated to a third party’s interest in such good if the following factors are satisfied:

(i) the leased good becomes an "accession" to other goods;

(ii) the subsequent buyer acquires the entire set of goods in good faith, without knowledge that the lessee is not the true titleholder to the individual good that has become an "accession";

(iii) the transaction occurs in the ordinary course of business of such buyer; and

(iv) the purchase is from a seller whose business is selling goods of the kind that has been purchased.

The appellate court rested its decision on the fourth factor finding that, as part of a prior bankruptcy filing, FINOVA’s business plan was limited to an orderly liquidation of its portfolio of aircraft over time in an effort to wind down its operations and dissolve its entities. The appellate court determined that FINOVA was selling the aircraft to pay creditors as part of such liquidation, and that FINOVA was not engaged in the business of leasing aircraft or selling aircraft to third parties in connection with a leasing and financing business. Accordingly, the court (i) ruled that the Buyer in Ordinary Course Exception did not apply, (ii) recognized RPK’s title to the thrust reverser and (iii) ordered WFB to return the thrust reverser to RPK.

Conclusion

Because the appellate court in the RPK Case did not address the threshold question of whether the thrust reverser was an accession to the aircraft, it remains uncertain whether major aircraft parts, such as thrust reversers, landing gear or auxiliary power units would constitute accessions.5 Lessors of major aircraft parts should nonetheless take heed of the court’s analysis as there are certainly market factors that support the conclusion that aircraft parts less substantial than engines would constitute accessions. To the extent such parts do constitute accessions, lessors of major aircraft parts are subject to the risk that a Buyer in the Ordinary Course may acquire title to such parts free and clear of any interest of the lessor.

In light of the RPK Case and the attendant risks presented by the Buyer in Ordinary Course Exception, lessors of major aircraft parts should ensure that their lease agreements contain provisions that impose obligations on lessees designed to reduce the risk that a Buyer in the Ordinary Course may acquire title to such parts. Potential lease provisions include those imposing affirmative obligations on a lessee of a major aircraft part to take the following actions:

(i) Install Data Plates: require the lessee to physically mark the leased parts by installing a data plate identifying the parts as being owned by the lessor;

(ii) Placards: require the lessee to place a placard in a prominent place in the cockpit or cabin of the aircraft on which such parts are installed identifying the lessor as the owner of the leased part;

(iii) Lessee Reporting Obligations: require the lessee to notify the lessor, and require the lessor’s consent, of any proposed installation of a part on a different aircraft; and

(iv) Acknowledgment from Aircraft Owner/Financier: to the extent a leased part is installed on an aircraft that the lessee leases from a third party or is subject to third party financing, require the lessee to obtain a written acknowledgment from an aircraft owner or financier consenting the installation of the leased part on the aircraft and disclaiming any interest in the leased part.

While it is impossible to eliminate the risk that an unscrupulous lessee may transfer title to an aircraft on which a leased part is installed, lessors of major aircraft parts can certainly reduce the risk of losing title to their leased parts in connection with any such transfer through proactive asset management coupled with lease agreements containing some or all of the provisions described above.

1Wells Fargo Bank Northwest, N.A. v. RPK Capital XVI, L.L.C. and RPK Capital Management, L.L.C., 360 S.W.3d 691 (Tex. App. Dallas 2012).2 A "buyer in the ordinary course of business" is a person that buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind. A person buys goods in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller’s own usual or customary practices. A buyer in ordinary course of business may buy for cash, by exchange of other property, or on secured or unsecured credit, and may acquire goods or documents of title under a preexisting contract for sale. Only a buyer that takes possession of the goods or has a right to recover the goods from the seller under Article 2 of the UCC may be a buyer in ordinary course of business. See UCC Section 1-201(9).3See UCC Section 2A-305.4 A good becomes an "accession" when it is installed in or affixed to other goods, thereby resulting in the “accession” becoming part of the whole. The interests of a lessor or lessee under a lease contract entered into before the goods became accessions is superior to all interests in the whole, subject to the Buyer in Ordinary Course Exception (and a similar exception for creditors). The interests of a lessor or lessee under a lease contract entered into at the time or after the goods became accessions is superior to all subsequently acquired interests in the whole, subject to the Buyer in Ordinary Course Exception (and a similar exception for creditors), but is subordinate to interests in the whole existing at the time the lease contract was made unless the holders of such interests in the whole have in writing consented to the lease or disclaimed an interest in the goods as part of the whole. See UCC Section 2A-310.5 In your typical operating lease for an aircraft, the lessee is oftentimes permitted to return the aircraft at lease-end with replacement parts in lieu of parts installed on the aircraft at delivery (including major parts such as engines, thrust reversers, landing gear and auxiliary power units), subject to such replacement parts satisfying conditions specified in the lease. If a lessee does redeliver an aircraft with a replacement engine, the lessor and the lessee typically document the transfer of title to the engines by exchanging bills of sale for both the original engine and the replacement engine, which lends support to the conclusion that an engine is not an accession to the aircraft. However, the practice of separately documenting a title transfer in connection with a part replacement is less common for thrust reversers, landing gear and auxiliary power units. In these circumstances, the parties oftentimes rely on the general lease provisions that provide that title to such a replacement part automatically transfers to the lessor, and title to the replaced part transfers to the lessee, upon installation of the replacement part on the aircraft. Furthermore, as part of a buyer’s due diligence in connection with the purchase and sale of a used aircraft, it is common for the buyer to request a copy of a bill of sale for each engine evidencing transfer of title of each engine to the seller (and oftentimes back-to-birth bills of sale evidencing the chain-of-title to each engine back to the manufacturer), again supporting the position that an engine is not an accession to the aircraft. This same practice does not exist for less substantial aircraft parts, such as thrust reversers, landing gear and auxiliary power units, primarily because title transfers of major aircraft parts less substantial than an engine are not documented separate and apart from a general reference to "parts" on a bill of sale for a whole aircraft. While these market practices with respect to the documentation of title transfers for major aircraft parts are not determinative, they certainly suggest that aircraft parts less substantial than an engine may constitute accessions in that the market does not view it as necessary to separately document title transfer for such parts (apart from an aircraft as a whole).

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